Jane the Actuary Retirement

Forbes post, “Public Pensions And Social Trust”

Originally published at Forbes.com on March 17, 2019.

 

So it seems that I hit the one-year mark of my writing on retirement at this platform, and have still not managed to address some of the topics I wanted to discuss, in particular, questions of what pensions look like abroad and what we can learn from them.  But right now I find myself thinking about international comparisons in another way, around the question of social trust.

Round about a year ago, Megan McArdle, formerly a Bloomberg columnist and now writing at the Washington Post, wrote a series of articles coming out of a visit to Denmark.  Her first, at Bloomberg (paywalled), expresses the gist of the article in its title, “You Can’t Have Denmark Without Danes; What a small, happy country can teach a huge and fractious one. And what it can’t.”  Fundamentally, Demark can do what it does and function as well as it does because of its considerable degree of social cohesion; a sense of cohesion that, to her understanding, was not the result of an expansive welfare state but a precondition for its success.  (She subsequently expanded on this in a series of tweets, though non-subscribers will miss out on what I vaguely recall, from pre-paywall days, to have been an anecdote about losing her wallet and having it returned.)

She subsequently wrote again on the topic of the Danes’ system of disability and the country’s level of social trust at the Washington Post, observing that it has very generous social insurance provision of such benefits as disability income replacement with neither the sort of cheating nor the fears of cheating that you’d see elsewhere, including, yes, the United States, where one periodically sees reports of city workers taking advantage of generous disability pay-replacement and being seen out and about engaging in all manner of activities that indicate their claims of incapacity are fraudulent.

“Social trust” is, well, what it sounds like: How much do you trust your neighbors? And in turn, how trustworthy are they? In a low-trust place such as Greece, people don’t trust their neighbors not to cheat, which in turn makes them more likely to cheat themselves, because why should you stay honest when everyone else is getting away with something? This affects everything: whether people pay their taxes, whether they take benefits they don’t really need, how easy it is to regulate companies. And social trust also works as a productivity booster, because you can do away with a lot of the cumbersome monitoring that is ubiquitous in modern societies — the supervisors who oversee low-level workers, the store clerks who keep an eye on the customers. Every worker who is not making sure that people don’t steal or shirk can be re-employed doing something that actually increases output.

The United States simply doesn’t have that level of trust. And while it would be nice to think that we could get there if companies and government simply stopped acting so suspicious, the fact is that they frequently act suspicious because, well, Americans cheat more than Danes do. (Compare, for example, the American and Danish rates of tax evasion). Moreover, the mutual suspicion that Americans feel for each other restricts the range of politically feasible policies. Even if people aren’t cheating on benefits, if there is a widespread social belief that your fellow citizens might, you will not be willing to support a generous welfare state. (This helps explain why support is highest for old-age benefits in the United States; it’s hard to fake turning 65).

I find myself revisiting this article in light of both my own articles on prospects for public pension reform in Illinois (among others, my own proposal for reform and  my pessimism that Illinois politicians even recognize the importance of pension funding in the first place) and models for improved systems such as Wisconsin’s (and — spoiler alert — there are other systems with risk-sharing elements which I’ll profile soon) as well as the politics around Illinois Gov. JB Pritzker’s proposal for a graduated income tax.  In both cases, any such legislation requires amendments to the constitution Illinois adopted in 1970.  And in both cases, Illinois faces a lack of social trust.

Does a statement about public employee pensions belong in the constitution?  As it turns out, Illinois is only one of two states (the other is New York) with an explicit guarantee protecting future accruals.  (Others guarantee this by means of state supreme court decisions.)  Does it make sense to prohibit a graduated form to an income tax in a state constitution? Illinois, Michigan, and Massachusetts are the only ones which do so.   (North Carolina passed an amendment capping income tax rates to 7% in November 2018; in a peculiar turn of events, this was overturned in a February court decision because of the claim by plaintiffs that the state legislature was invalidly gerrymandered.  The decision is being appealed.)

As the Chicago Tribune reported in 2013, no thought was given in the 1970 discussions to the question of funding those pensions:

In short, state and local governments would be required to keep their pension promises but not be required to sock away enough money to cover payments years into the future. When it came to funding, officials of both parties in Illinois took significant advantage of the escape clause, helping them skate by for decades without having to make politically difficult decisions on raising revenues or cutting services to meet pension obligations.

In May 1971, just weeks before the new constitution would go in effect, an official state pension oversight panel of lawmakers and laymen issued a report warning that the new pension safeguards were a mistake.

The Illinois Public Employees Pension Laws Commission, which no longer exists, said it had opposed the language inserted into the constitution and had asked one of the sponsors to soften it or at least read a statement into the convention record that it wouldn’t preclude “a reserved legislative power” to change benefits in order to keep retirement plans sound.

Nothing came of the request, the report noted.

As it happens, I’m on record in support of removing both these clauses from the Illinois constitution in one fell swoop.

But to raise the issue of a change to the constitution in either of these respects raises fears:  how can we trust the legislature to use their newly-expanded powers reasonably, sensibly, justly?  Republicans will cut the pensions of hapless retirees!  Democrats will recklessly raise taxes!  In comments at my personal website JaneTheActuary.com and via Twitter @JanetheActuary, readers told me that they simply could not believe that Illinois politicians would make the hard political decisions needed to reform pensions, when it would cost them votes and would cost them campaign funds.  And similarly with respect to the proposed income tax amendment, opponents raise objections that this is just Pritzker’s opening bid, but that, once the limits on graduated income taxation are removed, the Democratic supermajority will be unfettered in its tax-and-spending spree.

It is, in the end, the fruit of a long history of corruption in Chicago/Chicagoland and Illinois.  After all, just this past February, the Chicago area was named the most corrupt in the nation, based on its share of corruption convictions.  Statewide, Illinoisians can now breathe a sigh of relief that our past two governors appear not to have been criminals, unlike their two predecessors.  Reforming pensions and instituting risk-sharing mechanisms simply can’t happen if Illinois voters don’t trust that their politicians will seek to make fair decisions.

 

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.

Jane the Actuary Retirement

Forbes post, “Public Pensions And Public Trust”

Originally published at Forbes.com on August 15, 2018.

 

What should states be doing with respect to retirement benefits for their workers?  Is it just a political debate, like everything else?  Red vs. blue, left vs. right?  Here in Illinois, at least, it’s a much more fundamental issue, one of public trust.

Recall that our state plans are among the worst-funded in the nation.  Local municipal plans are also in terrible shape and the source of massive tax hikes and shortfalls in city services.  A recent analysis by the Illinois Policy Institute documented the degree to which pension spending is sucking up property tax revenue that would otherwise go to providing services.

And the reason is not simply deferred contributions, but benefits which far exceed the private sector in their generosity after multiple increases in benefit levels, reductions in retirement age, increases in COLA (see my prior listing of benefit increases at the state level) — increases which, to their credit, legislators tried to remedy with a Tier II benefit for new hires starting in 2011, but by then the horse was already out of the barn, in terms of benefits already guaranteed to state workers, amounts which are simply massive.

But, more immediately, the city of Chicago and Mayor Rahm Emmanuel have proposed issuing Pension Obligation Bonds to the tune of $10 billion.  As explained by Adam Schuster at the Illinois Policy Institute, the city is marketing this as, basically, free money, with the expectation that they’ll be able to gain more money in investment earnings than they’ll spend in interest payments on the bonds — a sort of shell game which wouldn’t fly as a means of generating cashflow for ordinary city spending and shouldn’t be on the table here, either.  What’s more, due to the city’s credit rating, Schuster writes,

Officials suggest the plan may leverage a financial vehicle known as securitization, putting taxpayers on the hook by dedicating specific revenue streams to ensure the bonds are repaid. In other words, bondholders would be guaranteed repayment while taxpayers face the prospect of service cuts or tax hikes in the event of a downturn.

Does this mean that investors are guaranteed their return even in case of bankruptcy?  I’m not expert enough to know.

And Chicago’s pensions are even more poorly funded than those of the state of Illinois, with a funding ratio of 27% across all City of Chicago plans, due to the same combination of generous benefit promises and poor funding.

This is a violation of public trust. 

In order to gain the short-term benefits of public approval for their spending initiatives without the pain of taxes, in order to get union support for their re-election campaigns, in order to promise everything now, without regard to the impact of their actions on future generations, politicians in Chicago and in Illinois happily increase benefits and defer funding.  And, again, the Democratic candidate for governor, and likely next governor, has no intention of remedying the situation.

I had previously written that public pension pre-funding is vital as a matter of good governance and fiscal responsibility.  But I’ll be honest with you:  the example of Illinois and Chicago make me very dubious that we can rely on states to follow through on whatever commitments they make with respect to funding their pension promises from year to year.  Whether that’s by simply not making required contributions, or developing delusionally-optimistic contribution schedules, the temptation is simply too great to borrow from future generations in ways that are hidden and conform, on paper, to balanced-budget requirements.

Now, perhaps in other cities and other states, these games are incomprehensible.  It is true that there are a few bright spots in public pensions, such as Wisconsin’s risk sharing pension (watch this space . . . ), but Illinois is hardly the only such state; New Jersey is similarly troubled, as outlined in an op-ed even just today.  And politicians now in office might defend themselves by arguing that it was their predecessors that got created this problem, but that doesn’t remedy our current situation.

The bottom line is that I simply don’t see any path forward other than removing states and municipalities from the business of running pension plans.  If unions don’t want their members subject to the risks of individual accounts, let them run plans for their members and take on the risk themselves, negotiating with employers for fair contribution levels in line with the private sector and educating their membership on the need for additional voluntary contributions.  But we can’t keep the system as it is.

 

December 2024 Author’s note: the terms of my affiliation with Forbes enable me to republish materials on other sites, so I am updating my personal website by duplicating a selected portion of my Forbes writing here.